Joe Downs explains the valuation formula for self-storage facilities: NOI divided by cap rate equals value. He shows how to adjust seller numbers for realistic vacancy and expenses, why local cap rates matter more than national averages, and how the 70% rule protects you from overpaying. Start with a lowball offer to anchor negotiations.
Chapters
Welcome to day 39 of the Storage 100. I am Joe Downs of the Storage Mastermind, and today I want to bring to focus one of the most important questions in real estate: how much do you actually offer? To answer that question though, we have to learn, uh, how we need to start thinking about the offer and what goes into the offer. And to do so, I'm going to break down the valuation formula so you never overpay for a storage facility again. The formula is simple. Net operating income divided by cap rate equals the value. But the devil is in the details of those 2 numbers. If you get the NOI or the cap rate wrong, you'll pay too much. So let's start with the basic math. The napkin math is where every deal is going to start. So, and it's the core of the valuation formula. You need to understand these 3 variables before you look at a single deal. Remember, NOI is your net operating income, which is the profit before you pay any debt service. The cap rate is the market rate return. Market rate return or market return rate, you can say it either way. And it's essentially a measure of the risk. So you take your NOI, divide it by the cap rate, and that gives you the value, which is your purchase price or purchase offer. Look at the example. $100,000 in NOI divided by a 7% cap rate gives you a value of about $1.43 million. Seems pretty straightforward, but the seller's NOI is almost never the true NOI for you anyway. And so we'll need to dig into that number and see what it's made of. And this is where most people get burned. You have to find your true NOI. Not the seller's NOI. We all have heard the saying, the my truth and your truth. And this is the kind of the one area where that there can actually be 2 true truths, because the way the seller runs a facility might be different the way than— in fact, I can almost guarantee you a lot of times it'll be different the way that you're going to run the facility. And then there's also sellers you need to be careful with. So because they're sometimes motivated to inflate that number and they may use some tricks here and there. to inflate it that if you're new, you may not really pick up on right away. Sometimes they can show you zero vacancy, for instance, in their pro forma, zero management fees because they manage them themselves, and they might even understate taxes or maintenance and lawn care or whatever it is. Your job as the buyer is to be realistic. How are you going to manage the facility? You've got to factor in some market vacancy. You need to factor in maybe some professional management fees. And what if the taxes go up after the property sold or reassessed at some point in the future? In this ultra simplistic example, and I say ultra simplistic example, the seller says the NOI is $90,000, but the buyer's realistic math shows that it's only $69,000. And that difference changes the value of the property significantly. Think about it this way. At a 7% cap rate, that $21,000 difference in NOI is a $300,000 delta in price. You paying attention now? But the NOI is only half the equation. Now we have to tackle the cap rate myth. You cannot use a national average cap rate you found on Google. Cap rates are local and they reflect risk. A 4% or 5% cap rate might be a Class A property in a prime location in downtown New York City, whereas on the other end of a scale, an 8% to 10% cap rate, you might find in a riskier— depending on how you define risk— but a more rural tertiary market. Where it might be more of a value-add property instead of a Class A property. If you take that $100,000 NOI and use a 5 cap rate on it, you get a $2 million valuation. But if the local reality is more like an 8 cap, the fair market value is actually only $1.25 million. So in that scenario, you just overpaid or offered to overpay by $750,000 because you're using the wrong cap rate. Cap rates are sensitive if you can't tell. You have to know what market and asset class you're in and what cap rate is appropriate and associated with that based on that. All right, so let's talk about now how we use these formulas to create wealth. The value-add play is one of the best ways to make money in self-storage. We buy based on the current NOI, but we get rich on the future NOI. So look at this example. The current state of this facility, it's got low rents, low occupancy, and it's spitting off $50,000 of NOI, which gives it a value of about $714,000. When we— if we buy it at that price, and we would all day long if we like the market it's in based on the occupancy and the rental income, and then we execute our plan, Over time, we're going to raise rents to market and increase the occupancy because we're going to spend money on marketing. That's going to double the NOI to $100,000. Now that property is worth $1.42 million. We just created $700,000 of equity simply by executing our business plan. That's the power of the valuation formula when you focus on the future. Okay, so that's the value-add play. But now we need a formula to make sure we don't overpay for that opportunity. And this is where we're going to use the 70% rule. And that formula is very simple as well. You take the stabilized value, so that's the value of the property, the NOI divided by the cap rate. We multiply it by 70% and then subtract our repair costs. That 30% margin is your safety net. It's going to— it can cover your profit, your holding costs, and every mistake you will inevitably make. If you break this rule, you're gambling, you're not investing. This is for, by the way, a deep value-add property where there's some physical value-add as well. We're going to use this formula to set our absolute maximum offer price, but we don't start there. 70% rule gives us our ceiling. We always start with the lowball strategy. So if you aren't— there's a saying, if you aren't embarrassed by your first offer, you offered too much. This is, this is all about anchoring bias though. The first number you put on the table sets the entire negotiation range. You want that anchor to be low so the final price you, the final price you agree to is pulled down toward your number. A low offer also serves as a motivation test. It immediately reveals how desperate the seller is to exit that deal. Don't fear rejection. A no just means the negotiation has officially begun. You have to be willing to walk away to get the best deals. All right. So let's look at the tool we use to run these numbers. The offer calculator is the tool we're going to use here to make sure our lowball offer is grounded in reality. This is how we're going to determine the stabilized value we used in rule— in the 70% rule. So you're going to take again the gross income, subtract your expenses to get the net operating income or NOI. Then we're going to divide that NOI by our target cap rate, which is the market rate for the area. That's going to give us the maximum price we can pay for this physical value-add property to still hit our return goals. Notice how we're basing the value on verifiable income, by the way, and not just what the seller says it's— says the income is and what it's worth. And we use this simple formula to defend against emotionally overpaying. It's the only way to ensure you buy right. This entire process, the 70% rule, the lowball strategy, the offer calculator, it's all designed to protect you from you. It takes the emotion out of the deal and forces you to stick to the numbers. Okay. Like and subscribe if this helped you think about making offers differently. Next up tomorrow, day 40, we're talking about seller financing. And the ultimate cheat code. And lastly, share this with a friend who's bad at math. They'll thank you later.
